Well placed for infrastructure investment?

Following the Conservative party conference infrastructure spending is back in focus.

Chancellor Phillip Hammond has outlined tight control on regular spending but is targeting greater infrastructure spending to reignite economic growth and to counteract some slowdown in private investment post the referendum vote.

Investment in infrastructure should be viewed as the foundations of a modern economy by building roads, railways, airports and improving telecommunications. It is also an attractive time for government to invest given borrowing costs are at an all-time low. The aim of infrastructure spending is to encourage new businesses to be set up in construction and engineering, leading to the creation of new jobs. Existing firms will have greater access to new markets and better connection to customers. It will also encourage the existing workforce to mobilise to find new job opportunities. Fundamentally this increased government spending is designed to have a multiplying effect by achieving greater overall wealth from the initial investment, creating economic growth, lower unemployment and higher future tax receipts for the government.

Support Services

Below is a list of support service businesses that offer higher returns on capital than the counterparties they serve in the construction sector. We have selected support services as a possible avenue for investing for higher infrastructure spending by government, as they gain indirectly as suppliers to the construction sector. With the benefit that they do not face the low margins and high competitive bidding process that has undone many construction cycles over several decades. Support services are also less exposed to operational problems the industry faces in bringing projects on time and on budget and will have exposure to international construction programs, diversifying country specific risks.

Conclusion

As with much of the current equity market, construction valuations appear to be up with events and are at a relative historic premium to the support service businesses selected for their exposure to construction. The table also demonstrates one major attraction to the support service industry is their return on capital employed (ROCE); an indicator of profitability against the working assets within the business. Over the long term these businesses will grow faster than sectors with a naturally lower ROCE and should see outperformance in the share price.

construction support services

construction and building materials

* P/E: Price/Earnings ratio; the ratio of a company’s share price to its per-share earnings.

** EV/EBITDA: Enterprise value/Earnings before interest, taxes, depreciation and amortisation. Used as a valuation tool allowing investors to compare the value of a company
to the cash earnings less noncash expenses. Typically, a value less than 10 is considered healthy.